Yes Virginia, You Can (Safely) Deny the Duty to Defend in Washington

Believing a liability insurer can safely deny the duty to defend in Washington, without filing a declaratory action and defending under a reservation of rights, seems tantamount to believing in Santa Claus. The Honorable Richard Jones, of the Western District of Washington, proved otherwise in Chase Construction North West Inc. v. AIX Specialty Ins. Co., No. C15-19RAJ (June 23, 2015 W.D. Wash.). Judge Jones held that a condominium exclusion precluded the duty to defend against construction defect allegations. He reached this decision when the insurer denied the duty to defend or indemnify with a good old fashioned denial letter. The insurer did not sue its insured in a declaratory action or go to the expense of hiring defense counsel to defend under a reservation of rights. Some might argue this was rash, but later events confirmed otherwise.

In this case, a condominium homeowners association sued the insured contractor for defectively replacing the roofs on two buildings the condominium owns that contain numerous residential condominium units. Based on a condominium exclusion we describe below, the insurer denied any duty to defend or indemnify. The condominium association sued the insurer alleging it breached the insurance contract by incorrectly denying any duty to defend or indemnify, and the insurer violated Washington’s Insurance Fair Claims Act (“IFCA”) (a statute frequently discussed here that awards beaucoup bucks for “unreasonable denials”). Somewhat (who am I kidding? I nearly dropped dead from shock) to our most pleasant surprise, Judge Jones granted the insurer’s summary judgment and dismissed the entire suit, including the IFCA claims.

The condominium exclusion, which proved decisive here, says there’s no coverage for “‘property damage’ … arising from any work or operations [the insured contractor performs] in connection with any condominium.” Coverage is returned for “repair or remodel work done on condos … if such work is being done under contract with the owner(s) of the single unit being worked on.” So the insured contractor can remodel a kitchen, paint the living room, or perform any myriad of tasks the owner of a single condominium unit owner might require. But work done on the condominium complex as a whole, with its greater liability exposure, is excluded.

The insured argued the exception for work on a single condominium unit is ambiguous. The insured focused on the word “unit.” “Aided” by a dictionary defining “unit” as “any group of things or persons regarded as an entity,” the insured argued that each of the buildings with the roofs the insured worked on—which the complaint alleged house multiple residential condominium units—could be a “unit” just as an individual condominium could be a unit. Hence the exclusion is ambiguous.

Judge Jones concluded the insured’s argument: “leads to an interpretation of the Condo Exclusion that no sensible insured would reach.” He reviewed some hypotheticals demonstrating how ridiculous the insured’s interpretation is and held the exclusion “unambiguously excludes” the complaint’s allegations.

On the IFCA claim, the insurer argued (among other things) that IFCA does not apply to liability coverage claims because the statute’s language limits IFCA to first party claims. Judge Jones noted the split of authority among the judges of Washington’s Western District on whether IFCA applies to liability coverage claims. He cited his own recent decision, Cedar Grove Composting, Inc. v. Ironshore Specialty Ins. Co., No. C14-1443 RAJ (June 2, 2015 W.D. Wash.), in which he sided with those holding that IFCA applies to third party claims. But the Court did not have to reach the first vs. third party issue because the insured failed raise any factual issues on the insurer’s liability for bad faith or IFCA.

What should we take from this decision? Washington coverage lawyers often must advise insurers to defend under reservations of rights and file declaratory actions to guard against the dire consequences of unreasonably denying the duty to defend. But even in Washington, and even in its Supreme Court’s notorious Woo decision —you remember that one: putting boar tusks in an anesthetized patient’s mouth and taking her picture constitutes the practice of dentistry (we really wish we were making this up)—“an insurer is relieved of its duty to defend only if the claim alleged in the complaint is ‘clearly not covered by the policy.’” 161 Wn.2d at 60.

In the Chase Construction case, the policy excludes “‘property damage’ … arising from any work or operations [the insured contractor performs] in connection with any condominium.” A condominium homeowners association unequivocally alleged the insured contractor botched repairing roofs on buildings the condominium homeowners association owned. Because the allegations fall within the exclusion, the duty to defend can be denied outright, even under Washington law, “because the complaint is ‘clearly not covered by the policy.’” Id.

This case involved a type of exclusion increasingly used by insurers in recent years to avoid liability for construction defects. These provisions go by different names, such as Residential Construction, Condo, and others. Rather than attempting to exclude liability for what the insured does, these provisions exclude based on what the insured is working on. The intent is to avoid covering liability for damaging multi-unit developments. We understand standard language for these exclusions does not yet exist. So courts have rendered varying decisions depending on the language and allegations. These exclusions frequently have exceptions that return coverage under narrowly drafted language. Exceptions to exclusions are fertile ground for ambiguity arguments, and this case was no exception (sorry, couldn’t resist). Insurers should be encouraged that Judge Jones correctly interpreted the exclusion—and its exception— here and saw through the insured’s transparent attempt to define words without regard to their context.

Finally, this case proves that Washington insurers don’t always (they do sometimes, just not always) have to incur tens of thousands more in expense by defending under reservations of rights and filing declaratory actions. If the policy excludes the complaint’s allegations, the insurer may still deny the duty to defend outright and not risk extra-contractual exposure.

Our Insurance Coverage Group colleague Eric Chavez provided able assistance here. We’ll find out near the end of this month if the insured will move to modify the ruling or appeal. Keep your fingers crossed. But for now, at least for one insurer, it’s Christmas in July!